There are a number of investment options available before investors to choose from – while some are fully secured with sovereign guarantee, in some cases, even the capital invested is subject to some risks.
There are a number of investment options available before investors to choose from – while some are fully secured with sovereign guarantee, in some cases, even the capital invested is subject to some risks. However, the investment principle – ‘the higher the risk, the higher the return’ – applies on most set of investments. For example, capital invested in fixed-income returns is mostly safe, but the returns are lower in comparison to that of equity investments, where the capital invested is subject to market risks as well as company-specific risks.
So, which kind of investment is better for you – the safe one with lower return or the riskier one with the probability of higher return?
Although the best investment for an investor may not be a good one for another investor, as needs differ from person to person, there may be one general answer – shorter the tenure of investment, it will be better to choose safer investment options and longer the tenure, riskier investments would be better to meet the financial goals.
So, the most important thing to decide on where to invest is to prepare a comprehensive financial plan. The financial plan will help you to identify your financial goals – like higher study for self, getting married, buying a car, going for foreign travel, buying a house, fund required for education of children, fund for marriage of son/daughter, building retirement corpus etc. There may be other financial needs depending on requirements and ambitions.
Once the goals are identified, you have to categorise them in short-term, medium-term and long-term goals and quantify them by taking into consideration the present cost, duration to realise the goals and effect of inflation to determine how much funds you need in how many years to meet each life goal.
Shorter the duration of a life-goal, lower will be the effect of inflation and lower will be the capacity to take risks. So, for short-term goals, you have to depend on fixed-income instruments. On the other hand, longer is the duration of a life-goal, higher will be the effect of inflation, which will magnify the financial need at the time of occurrence of the event, but higher will be the capacity to take risks. So, to meet long-term goals, you may depend on equity investments that would beat the rate of inflation comprehensively to meet the higher requirements of funds.
So, depending on your income, you have to decide how much to invest to meet each financial goals individually, by taking minimum possible risk.
For short-term term goals, you have no option, but to choose the best available fixed-income instrument, depending on the rate of interest, protection of capital invested and liquidity. But for long-term goals, you have the option to choose fixed-income or equity, depending on how much you may spare to invest to meet the requirement.
For example, if the current fee for higher study is Rs 5 lakh and you have 18 years to accumulate fund for higher study of your child, taking into consideration over 8 per cent inflation in the education sector, you would need about Rs 20 lakh at the time of admission. Now, to accumulate Rs 8 lakh in 18 years, you may invest Rs 4,267 per month in a fixed-income instrument giving 8 per cent interest rate, or around Rs 2,810 in an equity fund with long-term CAGR of 12 per cent. Higher the duration, higher will be the gap of monthly investments between fixed-income and equity.
So, for long-term financial goals, you have to choose between fixed-income and equity instruments, depending on your investment capacity.
Hence, an investment avenue may be very safe, but may not be good for you to meet long-term financial need, unless it is able to fulfill the financial goal. On the other hand, an equity fund may be consistent to give 20 per cent long-term CAGR, but it will not be good for you to meet a short-term financial goal.
So, remember, there is no best investment, but the best investment is the one that suits your financial need.